Curious Corner

“NATIONS FAIL TODAY because their extractive economic institutions do not create the incentives needed for people to save, invest, and innovate. Extractive political institutions support these economic institutions by cementing the power of those who benefit from the extraction.”

― Daron Acemoğlu, Why Nations Fail: The Origins of Power, Prosperity, and Poverty

In their groundbreaking book Why Nations Fail: The Origins of Power, Prosperity, and Poverty, economists Daron Acemoglu and James A. Robinson challenge earlier theories of national success, such as those focusing on geography, culture, or purely economic factors. Instead, they introduce a novel argument: the fate of nations largely hinges on their political and economic institutions. Acemoglu and Robinson classify these into two types — inclusive and extractive institutions — arguing that inclusive institutions foster innovation and prosperity by providing broad participation and protecting property rights, while extractive institutions concentrate power and wealth in the hands of a few, leading to stagnation and poverty. 

Earlier there have been countless theories to decipher the factors that makes a society or nation successful? Some attributed success to the geography of land while some to the culture and values of people. However the theories of the past have give a mixed bag of results. And this novel theory based on the institutions (political and economical) that shapes the society seems to explain – why nations succeed a lot better tha it’s predecessors. It quotes many many examples from the ancient times to present to argue it’s result.

To understand the crux of this institutional theory, let us explores the characteristics of inclusive and extractive institutions and examines how they influence economic development, using real-world examples to illustrate their impact.

Inclusive Institutions

Inclusive institutions create a level playing field by providing equal opportunities and safeguarding property rights for a broad segment of society. They are characterized by:

• Broad Participation: Inclusive political institutions allow for wide participation in governance, ensuring that decisions benefit the majority.
• Property Rights: They protect property rights and allow citizens to engage in economic activities without unjustified alienation.
• Economic Opportunities: Such institutions encourage innovation and productivity by ensuring that individuals have incentives to contribute to economic growth.

South Korea (Post-1960s Development)

South Korea’s transformation from a war-torn, impoverished nation in the 1950s to a developed economy is a testament to inclusive institutions. After initial periods of military rule, the government implemented reforms focused on education, industrial policy, and infrastructure, while promoting private enterprise. South Korea also protected property rights, encouraged competition, and expanded political participation, allowing for an environment where individuals could invest in businesses and human capital. The result was the rapid emergence of globally competitive industries like electronics and automobiles.

Extractive Institutions

In contrast, extractive institutions concentrate power and resources in the hands of a few, often resulting in:

• Limited Participation: Extractive political institutions exclude the majority from decision-making, concentrating power among a narrow elite.
• Insecure Property Rights: They undermine property rights, allowing elites to exploit and control resources without regard for broader societal interests.
• Economic Inequality: These institutions stifle economic opportunities for the general population, leading to inefficiencies and stagnation.

Zimbabwe (Under Robert Mugabe) 

Zimbabwe is a more modern example of a country where extractive institutions have led to economic decline. Under Robert Mugabe’s regime, land and wealth were concentrated in the hands of the political elite. The government engaged in policies that undermined property rights, such as the violent seizure of white-owned farms, which led to a collapse of agricultural productivity. Political power was also concentrated, with Mugabe suppressing dissent and opposition through violence and coercion. These extractive practices caused hyperinflation, economic ruin, and a significant decline in the living standards of the majority of the population, while a small elite thrived.

The Interplay Between Political and Economic Institutions

Acemoglu and Robinson argue that political and economic institutions are deeply intertwined. Inclusive economic institutions often require supportive inclusive political institutions to thrive. For instance, the protection of property rights and the encouragement of broad-based economic participation are supported by democratic governance structures. Conversely, extractive economic institutions typically accompany extractive political systems, reinforcing power imbalances and inhibiting economic growth.

Historical and Modern Examples

The Glorious Revolution

The Glorious Revolution of 1688 in Great Britain marked a crucial shift from extractive to more inclusive institutions, setting the stage for long-term economic growth and the Industrial Revolution. Before the revolution, political power was concentrated in the monarchy, which controlled economic resources for elite benefit. Property rights were insecure, and political participation was limited, stifling innovation and economic progress. However, after the revolution, the establishment of a constitutional monarchy limited royal power and enhanced Parliament’s role, creating a more stable and inclusive political environment. This change secured property rights, strengthened the rule of law, and incentivized private investment, entrepreneurship, and trade, leading to broader economic participation.

This shift laid the foundation for Britain’s Industrial Revolution, as inclusive political institutions encouraged technological advancements and competition. The newfound stability and openness allowed for economic opportunities to be accessed by a wider section of society, not just the aristocracy. Britain’s transition demonstrates how inclusive governance can spark economic dynamism by creating an environment where innovation thrives, ultimately transforming it into a global economic leader.

China’s Economic Boom

China’s recent economic success is largely due to market reforms introduced in the late 1970s, which created more inclusive economic policies while maintaining extractive political control. Deng Xiaoping’s reforms opened up the economy to foreign investment, private enterprise, and market liberalization, fostering rapid growth, especially in special economic zones. These economic reforms incentivized entrepreneurship and industrial productivity, transforming China into one of the world’s leading economies. However, China’s political system, controlled by the Chinese Communist Party, remains highly centralized, limiting political participation and freedoms.

Acemoglu and Robinson caution that while inclusive economic policies have spurred China’s growth, the continued presence of extractive political institutions poses a risk to long-term stability. They compare China to the Soviet Union, which also achieved rapid growth under extractive political institutions but eventually collapsed due to inefficiencies and stagnation. Without political reform toward inclusiveness, China may face similar challenges, as extractive political systems tend to undermine innovation and create instability over time. And many could clearly see the red flags of the coming downfall in the Chinese economy.

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The comparison of inclusive and extractive institutions underscores their profound impact on economic development. Inclusive institutions promote broad-based participation, protect property rights, and encourage innovation, leading to sustained growth and prosperity. In contrast, extractive institutions concentrate power and resources, stifling economic opportunities and perpetuating inequality. By understanding these dynamics, policymakers and scholars can better address the challenges of economic development and work towards creating institutions that foster long-term prosperity.

Even tough this theory is new but the core logic given in it’s support is fairly straight forward and has been at least partially known since ages. The key to growth and development of the society is innovation. This innovation in turn makes the society more productive and efficient. However society need to motivate people to innovate, which is very difficult in a extractive society. As extractive society tends to extract any production surplus for it elite class thus leaving no incentive for common person to innovate and produce more. So in order to grow and develop, society needs to provide inspiration to maximum number of people to innovate. For this the society must be inclusive about sharing the benefits that comes with innovation. Hence the need to make society more and more inclusive.